Current General Studies Magazine (August 2014)

General Studies - III (Economy based Article)

Fiscal Responsibility and Budget Management (FRBM) Act, 2013

The Fiscal Responsibility and Budget Management Act, 2003 (FRBMA) is an Act of the Parliament of India to institutionalise financial discipline, reduce India's fiscal deficit, improve macroeconomic management and the overall management of the public funds by moving towards a balanced budget. The FRBM Rules impose limits on fiscal and revenue deficit. Hence, it will be the duty of the Union government to stick to the deficit targets. It also empowers RBI for taking measures to control Inflation.

The Act also provide exception to government in case of natural calamity and national security. The Rules required the government to restrict fiscal and revenue deficit to 45% of budget estimates at the end of September (first half of the financial year).In case of a breach of either of the two limits, the FM will be required to explain to Parliament the reasons for the breach, the corrective steps, as well as the proposals for funding the additional deficit.

The main purpose was to eliminate revenue deficit of the country (building revenue surplus thereafter) and bring down the fiscal deficit to a manageable 3% of the GDP by March 2008. However, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the act was initially postponed and subsequently suspended in 2009. In 2011, given the process of ongoing recovery, Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA.

States level fiscal responsibility legislations in India

The tenth plan of the Planning Commission of India highlighted the need for fiscal discipline at even the level of the states. This was to reduce the debt-to-GDP ratio of India. Reserve Bank of India(RBI),in its role as the ultimate financial authority in India, was also a keen supporter of the concept and publicly highlighted the need for state level fiscal responsibility legislations in India. By 2007, the states of Karnataka, Kerala, Punjab, Tamil Nadu, Maharashtra and Uttar Pradesh are among those which have already legislated the required fiscal discipline laws at the state level.

Content of the Act

Since the act was primarily for the management of the governments' behaviour, it provided for certain documents to be tabled in the Parliament annually with regards to the country's fiscal policy. This included the following along with the Annual Financial Statement and demands for grants:

1. A document titled Medium-term Fiscal Policy Statement – This report was to present a three-year rolling target for the fiscal indicators with any assumptions, if applicable. This statement was to further include an assessment of sustainability with regards to revenue deficit and the use of capital receipts of the Government (including market borrowings) for generating productive assets.

2. A document titled Fiscal Policy Strategy Statement – This was a tactical report enumerating strategies and policies for the upcoming Financial Year including strategic fiscal priorities, taxation policies, key fiscal measures and an evaluation of how the proposed policies of the Central Government conform to the 'Fiscal Management Principles' of this act.

3. A document titled Macro-economic Framework Statement – This report was to contain forecasts enumerating the growth prospects of the country. GDP growth, revenue balance, gross fiscal balance and external account balance of the balance of payments were some of the key indicators to be included in this report.

The Act further required the government to develop measures to promote fiscal transparency and reduce secrecy in the preparation of the Government financial documents including the Union Budget.

Fiscal management principles

The Central Government, by rules made by it, was to specify the following:

1. a plan to eliminate revenue deficit by 31 Mar 2008 by setting annual targets for reduction starting from day of commencement of the act.
2. reduction of annual fiscal deficit of the country
3. annual targets for assuming contingent liabilities in the form of guarantees and the total liabilities as a percentage of the GDP

Borrowings from Reserve Bank of India

The Act provided that the Central Government shall not borrow from the Reserve Bank of India(RBI) except under exceptional circumstances where there is temporary shortage of cash in particular financial year. It also laid down rules to prevent RBI from trading in the primary market for Government securities. It restricted them to the trading of Government securities in the secondary market after an April, 2005, barring situations highlighted in exceptions paragraph.

Exceptions

National security, natural calamity or other exceptional grounds that the Central Government may specify were cited as reasons for not implementing the targets for fiscal management principles, prohibition on borrowings from RBI and fiscal indicators highlighted above, provided they were approved by both the Houses of the Parliament as soon as possible, once these targets had been exceeded.

Measures to enforce compliance

This was a particularly weak area of the act. It required the Finance Minister of India to only conduct quarterly reviews of the receipts and expenditures of the Government and place these reports before the Parliament. Deviations to targets set by the Central government for fiscal policy had to be approved by the Parliament. No other measures for failure of compliance have been specified.

Implementation

Targets and fiscal indicators

Subsequent to the enactment of the FRBMA, the following targets and fiscal indicators were agreed by the Central government:

• Revenue deficit

• Date of elimination – 31 March 2009 (postponed from 31 March 2008)
• Minimum Annual reduction – 0.5% of GDP

• Fiscal Deficit

• Ceiling – 3% of the GDP by 31 Mar 2008
• Minimum Annual reduction – 0.3% of GDP

• Total Debt – 9% of the GDP (a target increased from the original 6% requirement in 2004–05)

• Annual Reduction – 1% of GDP

• RBI purchase of Government bonds – to cease from 1 April 2006

Four fiscal indicators to be projected in the medium term fiscal policy statement were proposed. These are, revenue deficit as a percentage of GDP, fiscal deficit as a percentage of GDP, tax revenue as percentage of GDP and total outstanding liabilities as percentage of GDP.

Jurisdiction

The residuary powers to make rules with respect to this act were with the Central Government with subsequent presentation before the Parliament for ratification. Civil courts of the country had no jurisdiction for enforcement of this act or decisions made therein. The power to remove difficulties was also entrusted to the Central Government.

Suspension and reinstatement

Implementing the Act, the government had managed to cut the fiscal deficit to 2.7% of GDP and revenue deficit to 1.1% of GDP in 2007–08. However, given the international financial crisis of 2007, the deadlines for the implementation of the targets in the act were suspended. The fiscal deficit rose to 6.2% of GDP in 2008–09 against the target of 3% set by the Act for 2008–09.However, IMF estimated fiscal deficit to be 8% after accounting for oil bonds and other off budget expenses.

In August 2009, IMF had opined that India should implement fiscal reform at the soonest possible, enacting a successor to the current act.This IMF paper was authored by two senior IMF economists Alejandro Sergio Simone and Petia Topalova and highlighted the shortcomings of the current law along with proposed improvements for a new version.

It was reported that the Thirteenth Finance Commission of India was working on a new plan for reinstating fiscal management in India. The initial expectation for revival of fiscal prudence was in 2010–11 but was further delayed. Finally, the government did announce a path of fiscal consolidation starting from fiscal deficit of 6.6% of GDP in 2009–10 to a target of 3.0% by 2014–15 However, eminent economist and ex-RBI Deputy Governor, S.S. Tarapore is quick to highlight the use of creative accounting to misrepresent numbers in the past. Furthermore, he added that fiscal consolidation is indeed vital for India, as long as the needs of the poor citizens are not marginalised. This need for financial inclusion of the poor while maintaining the fiscal discipline was highlighted by him as the most critical requirement for the 2011–12 Budget of India.

More recently, in February 2011, the PMEAC recommended the need for reinstatement of fiscal discipline of the Government of India, starting 2011–12 financial year. In FY 2011–12, it is almost certain that government will cross budgetary fiscal deficit target of 4.6% and it will be around 5%.

Criticism

Some quarters, including the subsequent Finance Minister Mr. P. Chidambaram, criticised the act and its rules as adverse since it might require the government to cut back on social expenditure necessary to create productive assets and general upliftment of rural poor of India. The vagaries of monsoon in India, the social dependence on agriculture and over-optimistic projections of the task force in-charge of developing the targets were highlighted as some of the potential failure points of the Act. However, other viewpoints insisted that the act would benefit the country by maintaining stable inflation rates which in turn would promote social progress.
Some others have drawn parallel to this act's international counterparts like the Gramm-Rudman-Hollings Act (US) and the Growth and Stability Pact (EU) to point out the futility of enacting laws whose relevance and implementation over time is bound to decrease. They described the law as wishful thinking and a triumph of hope over experience. Parallels were drawn to the US experience of enacting debt-ceilings and how lawmakers have traditionally been able to amend such laws to their own political advantage.Similar fate was predicted for the Indian version which indeed was suspended in 2009 when the economy hit rough patches.

Question:

1. What were the reasons for the introduction of Fiscal Responsibility and Budget Management (FRBM) Act, 2013? Discuss critically its salient features and their effectiveness. (200 words)

2. Critically examine Fiscal Responsibility and Budget Management (FRBM) Act, 2013.

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